Market Overview: It has been another week of gloom and doom in oil markets with further price falls predicted

By Eithne Treanor It was another week of doom and gloom on the oil market, but the International Energy Agency hinted that the market was in a rebalancing phase and OPEC called for stronger cooperation. The oil price got a slight and temporary reprieve late this week when prices climbed more than half a dollar.

That was to be short lived and the volatility continues. In early trading on Friday, Brent crude was priced around US$49.50 with WTI trading a couple of dollars lower above US$47 a barrel.

The oil price continues to grab the headlines, with traders and investors desperately looking for an illusive upside. The fall in the dollar boosted the market mid week, but oil is now trading at its lowest level since 1986. OPEC issued its January monthly oil market report on Thursday and said it expected oil demand growth to be 28.78 million barrels a day in 2015.

That’s lower than its pledged production quota of 30 million barrels a day and lower than its estimates for demand last month. Figures for December, according to secondary sources claim that OPEC has collectively been producing 30.20 million barrels a day. The situation for non-OPEC oil supply in 2015 is projected to grow by 1.28 million barrels a day, representing a downward revision of 80-thousand barrels from last month’s report as the lower oil price is taking some shale production off the market.

The low oil price is also taking jobs and investment off the market, an unwelcomed move at a time of economic uncertainty in the world. The announcements began in earnest this week with BP laying off staff in the North Sea. Shell cancelled a major petrochemical investment in Qatar said to be worth more than US$6 billion.

The oil services company Schlumberger said it was laying off 9,000 people from its operations and Statoil announced it was suspending its exploration projects in Greenland. Last week, Baker Hughes said that 35 horizontal rigs, used in tight rock formations such as North Dakota and in Texas were idled in what they say was “the biggest single-week drop since the drilling boom started six years ago.”

Analysts say this is just the beginning as the global oil industry is facing an entirely new reality with low oil prices. Cutbacks in the US and Canada are also being felt with Suncor Energy, Canada’s biggest oil sands producer reducing spending and laying off a thousand workers. One of the biggest operators in the Bakken shale formation in North Dakota announced it would cut expenditure by more than 40 per cent.

Analysts agree that OPEC’s move might have been a brave one, but there’s fear in the market that it might have backfired. David Kirsch, head of the consulting arm of Energy Intelligence says, “in terms of the oil market, this seems to be less of a situation where OPEC, and in particular Saudi Arabia, have embarked on a bold new strategy, and rather one that seems to have very quickly gotten away from them.”

While OPEC members were hoping that lower oil prices would shut in US unconventional production as well as helping to stimulate the flagging global economy, he says that neither of these scenarios has come to pass. Kirsch observes, “production changes in the US have been minimal, and the impact in 2015 looks for the moment to be one of slower growth, but still expansion, rather than contraction,” and adds, “the industry has slashed capex, but this is primarily directed at higher-cost, complex mega-projects that would deliver incremental volumes in the post-2020 period.”

The major investment banks are now reviewing their forecasts and few are optimistic about a fast reversal of fortunes in the oil industry. Goldman Sachs Group says oil will continue its decline and may have to fall to around US$40 a barrel for the market to turn. Goldman analyst Jeffrey Currie says that while OPEC resists any production cut, “output reductions will come from US shale drillers, who are pumping at the fastest pace in three decades.”

The bank said it now expects Brent crude to trade around US$43 a barrel in the next six months with WTI around US$39 a barrel. Looking at the 12-month timeframe, it sees some recovery with Brent around US$70 while WTI should average around US$65 a barrel. Currie says the market needs to “re-balance” and the only way to do this he fears will be for oil to fall further and hold a lower price for the first half of the year.

Living with OPEC’s decision will prove a tough time for the industry and Neil Atkinson; head of analysis at Lloyd’s List Intelligence says the market might have managed OPEC’s decision to leave its oil production quota of 30 million barrel a day unchanged, “the surprise, which rapidly turned to horror, was the speed of the subsequent unraveling of the oil price.

He adds a comparison, saying he “likened it to a bungee jump where the market has jumped off the cliff and is still hurtling down, occasionally getting snagged for a short time before breaking free and resuming the plunge.”

He also adds if Goldman Sachs and others are right about the vulnerability of oil projects “we might start to see in the second half of 2015 a slowing in the rate of growth of oil production from non-OPEC countries and for the years beyond we might have to revise downwards significantly our expectations of supply growth.”

The International Energy Agency also issued its January report this week and states, “while supply and demand forecasts have long pointed at a market imbalance and associated stock builds in the second half of 2014 and beyond, few would have expected such a sudden price collapse.”

The IEA is still hopeful for the longer term as it acknowledges that the selloff is having an impact. “A price recovery, barring any major disruption, may not be imminent, but signs are mounting that the tide will turn.”

Non-OPEC supply was revised downward from last month and the IEA say it will continue to fall for 2015. The agency says that oil production in the US is expected to remain robust and says the “call on OPEC and stock changes is now forecast to rebound to an average 29.8 million barrels a day just a shade below the group’s long-standing production target.” In response to the current situation and the IEA’s report, James Spence, managing partner of Cerno Capital in London, says the low oil price is an opportunity for investors.

“The seeds of recovery lie in oil’s fall as this is a self-adjusting commodity market.” He suggests a tight market will not last forever. “A set of investment opportunities hove into view, presenting a case for investing in the equity of whichever oil exploration company survives the current crash.”

The US dollar weakened as the Swiss National Bank expectantly dropped its minimum exchange rate against the euro. Analysts say this is a concern given the deflationary situation in Europe and its possible impact on other currencies. The interest rate in Switzerland has been negative for weeks. Oil tends to gain as the dollar weakens, but the dollar will not stay weak forever. Both benchmark oil prices are almost back at parity and one occasion mid-week, Brent fell below WTI, reflecting what traders feared was a very weak sea-borne spot oil market.

Where the oil price will go next is anyone guess, but the research team at Bank of America Merrill Lynch was not in optimistic mood this week. Their latest report says that the price will continue its downward journey, partly because “the contango in the Brent market is reaching epic levels last seen in 2009.” As oil stocks around the world continue to build, the bank sees storage numbers and OECD inventory levels heading higher.

In advance of the International Monetary Fund updating its world economic outlook next week, the IMF’s managing director, Christine Lagarde said that low oil prices would not be enough to deliver global economic growth as the situation was “too low, too brittle and too lopsided,” with many countries “still weighed down by the legacies of the financial crisis.”

Many countries are feeling the impact of low prices. The Venezuelan President Nicolas Maduro has been in talks with leaders in Saudi Arabia, Iran, Qatar, Algeria and Russia in an attempt to halt the slide in oil prices and establish stronger OPEC and non-OPEC relations and cooperation. The energy minister from the United Arab Emirates, Suhail Al-Mazrouei reiterated OPEC’s stance this week at the Gulf Intelligence UAE Energy Forum, calling on non-OPEC producers “to be rational and adjust their output according to the growth rate of oil supply in the market.”

He made it clear that no OPEC members were happy with the current price but added that OPEC “was concerned about the balance of the market but we cannot be the only party that is responsible,” and he said the UAE was not changing any investment plans, saying, “we aren’t going to act irrationally because of the drop in the oil prices.”

The UAE joins Saudi Arabia, Kuwait, and Qatar who may not feel the financial pinch immediately but American bank Citi says that Saudi Arabia will be forced to reduce state spending by 18 percent this year. Citi’s chief economist in the Middle East, Farouk Soussa says the fall in oil prices “is not a blip, it’s a structural shift.” Kirsch from Energy Intelligence says, “for the first time since the turn of the millennium, the OPEC producers are faced with forging a new consensus on what the appropriate price level or direction might be.”

OPEC is reluctant to call an emergency meeting, a situation Kirsch fears will mean, “the markets will continue without any real direction, and continue to plumb new depths.” In its current monthly magazine, the OPEC Bulletin, the foreword clearly states, “the organization has repeatedly stressed, and rightly so, that it cannot singlehandedly solve the problems of the oil market and nor should it be expected to.”

And goes on to say that the OPEC Secretary General is ready “to talk to anyone” adding that “a combined and coordinated approach is increasingly required if the current challenges are to be overcome.” OPEC’s January Monthly Oil Market Report. http://www.opec.org/opec_web/en/multimedia/351.htm